The question is liquidity, but what is the answer?
The world has seen a bifurcation in alternative asset allocations as investors have redefined what liquidity means to them following the global financial crisis, an AsianInvestor forum heard.
While those without short-term requirements have been pouring into private equity, there was a greater appreciation of the liquidity role that each investment plays within an overall portfolio, panellists told our sixth annual Southeast Asia Institutional Investment Forum in Singapore.
Audrey The, senior private investment specialist at Cambridge Associates, said there were two things at the forefront of investors’ minds: liquidity and yield. As a result, she said she had seen a strong pick-up in illiquid investing such as private equity as a growth engine.
She added she had seen external managers focusing more on liquidity and structuring investments to enable investors to get their money back earlier, including through warrants and other equity options.
However Andrew White, portfolio manager at SandAire Family Office – whose clients are families, charitable institutions and educational endowments – noted that while he was a fan in general of Ucits structures, they were inappropriate in certain circumstances.
“We get wary when people are trying to shoe-horn strategies into structures that are not appropriate for their liquidity profile,” he said. “We like to have liquidity, but we don’t want managers offering liquidity terms that they cannot meet.”
He explained that SandAire looked to run liquid portfolios, a reflection of the fact that the vast majority were invested in traditional assets. But he pointed to a distinction between a long-term investor and a buy-and-hold investor.
“As far as our asset allocation goes, if we want to make a big move it is generally going to be through ETFs, through things that are trading frequently. We do not require massive intraday liquidity,” White said.
The noted that liquidity was not a criteria that Cambridge used to evaluate managers. Rather, the firm weighs up the strategies, their track records and the market opportunity. All the panellists agreed it was impossible to put a number on the illiquidity premium.
On the question of hedge funds offering greater liquidity, Ernesto Prado, chief investment officer at Ayaltis, noted there was always a fashion for filling a void in demand. But he warned that seeking to cure an illiquidity problem in price by providing greater liquidity was laughable.
“If you gain greater liquidity, when there is an illiquidity crisis you are just going to get killed,” he said. “Your losses will be faster, which is why you should focus on making sure you hold your investors through a crisis.”
He stressed that private equity and private debt were still part of the same balance sheet, just different packaging. “It depends on how you structure your coupon payments, your commissions, your protection of principal and your convertibility into equity,” Prado said.
He suggested the answer to the liquidity question was being smarter in structuring assets to match liability profiles, such as in payout options rather than cash redemption. He likened a balance sheet to a building with different floors for senior debt, junior debt and equity.
“Every floor has a toilet and the one in the basement is the equity portion,” he said. “So you structure a very solid debt, secure your product and then you get the equity upside for free. That is how we think about it.”
The did not subscribe to the view that the asset class classification had disappeared, saying it was necessary to think about the role each investment plays in a portfolio, including using diversifiers within asset classes.
When the panellists were asked by the audience what techniques they used to measure liquidity, The said Cambridge looked at portfolios in aggregate, including what percentage of investments clients could redeem within four-six weeks. She agreed it was an important question that Cambridge needed to pay more attention to.
But Prado stuck to his guns, saying if investors were relying on liquidity to exit an illiquid situation they had already lost the game. He added that carrying out stress-test analysis was a lie.
“When you face a real liquidity crisis, the prices are not going to be there, the liquidity is not going to be there,” he said. “ALM is essential first of all, you need to be able to carry your investments through.”
White noted that SandAire talked to its external managers about the underlying liquidity of their portfolios, and measured the daily volume of ETFs it was invested in. But he pointed out that the families the firm represents had no liabilities to match.
It left moderator Peter Douglas, principal at CAIA Singapore, to reflect on two key takeaways in what he said had become a more sophisticated industry conversation: that liquidity always disappears when you need it most, and that there was a need to get the right manager in the right asset at the right time.